If you are considering building a custom home, you’ll want to understand the financing options you have for construction loans. Some homeowners have cash for a portion of the project but take advantage of low-interest rates to finance the rest. Some homeowners finance the entire project, while still others may have cash or reserves and not need financing. In this article we discuss the financing options for construction loans, which are subject to change, depending on the market conditions and loan programs available. However, this article will cover some of the financing options for construction loans and provide some consistent guides and valuable tips for financing options.
Lenders Must Have Construction Loan Experience
The first thing you will want to do is select a lender with construction experience. This is not the time or place for an online loan. A good place to start is by asking your builder who they have typically worked with in the past. Just like the vendors and sub-contractors that a builder works with, the builder has likely developed trusted relationships with local banks. Remember, the loan is a critical part of the home building process and you want the bank and the builder to work well together. You also want a financial institution that can process draws and the associated inspections in a timely manner, to keep your project on-schedule.
Many local and community banks have construction lending departments. Construction lending is a unique niche and you’ll want to make sure your loan officer and the lending institution has extensive experience in this area. Use the Questions About Financing Checklist to help facilitate your lender or mortgage banker selection process.
Keep in mind, too, that just because you qualify for a $3M loan doesn’t mean you should spend $3M. You want to ensure you’re living within your means and that the payment is affordable for you. The financing industry is ever-changing, as are the programs available. If you are working with an experienced construction lender, they should be able to guide you about the best programs and loan structure that meets your specific needs.
2 Parts to a Construction Loan
While production builders may offer “builder financing,” the more common approach, when building a custom home, is for the borrower to obtain a construction loan through a local lender. Construction loans are handled much the same as a regular home loan, except that there are often two elements to the loan:
- A loan to be used during the construction of the home and then,
- A permanent loan once the home is completed.
Due to the complexity of the construction lending process, the draw process, and other factors, the rates may be slightly higher during construction. Again, having an experienced construction lender is key. Your lender will conduct routine inspections as the home is built and typically require certain items to be completed before releasing any draws or payments to the builder. Keep in mind that because there is a 9-18 month gap between when you obtain the lot or construction loan and the permanent loan, the rates can vary greatly. You’ll need to plan for any eventuality so that you aren’t in a position of starting a project with one monthly payment and interest rate in mind and ending up much higher, depending on the rate environment.
Change Orders
Often, a construction loan requires you to adhere to a strict budgetary process, during your custom home building process. So, it will be very important to discuss and understand the implications of change orders during the building process. If, for example, the kitchen allowance was $100,000 but you decide to add a special feature or design element during construction, which puts the kitchen over budget by $15,000 – the lender, you, and the builder need to understand where the additional funds are coming from. If you are relying on your financing, you’ll want to be sure you adhere to the budget figures agreed upon by you, the builder, and your bank.
In our next article, we’ll discuss the different types of construction loans that are often utilized when building a custom home or purchasing a lot.
If you are thinking about building your once-in-a-lifetime custom luxury home, be sure to download our FREE ebook: “Designing & Building Your Custom Dream Home: How to Create an Experience You’ll Love to Remember.” Ready to get started? Contact Mueller Homes today, and let’s talk!
